Everyone Loves the Cloud Price Wars — For Now

For consumers, the recent price war over storage has been a pleasant surprise. For Internet companies, though, it's been a cause for an extended wave of high fives.

“One of my CEOs declared to me the other day that last week's activity in the cloud may have been one of the most important weeks in technology history, but we won't realize it for many years to come,” wrote Jeff Bussgang, a general partner at venture capital firm Flybridge Capital.

Why? Specialization is a powerful economic force. It fueled the Industrial Revolution, and it has quietly transformed the digital world.

Humans once did all their farming and building themselves, much like startups used to build out their own infrastructure. This was a necessary but not particularly efficient system.

As farmers and blacksmiths emerged to generate more labor through specialization, so have specialized cloud computing and services become the backbone that fuels startups and Fortune 500 companies alike. Netflix’s interface operates on Amazon Web Services (AWS) and has no plans of leaving, a spokesperson said.

Which is why last week's announcements of price cuts to the cloud services of Google and Amazon — two of the most widely used cloud services — resonated across the Internet.

The price is right

Picturelife, a startup that organizes users’ picture and videos, relies on Amazon cloud services, and its bills started piling up. When Google dropped its prices, the company began to consider a switch.

“We doubled the size of our photo archive and therefore our database as well. Then we started to see that this can be really expensive,” said Nate Westheimer, cofounder and CEO of Picturelife. “We knew it would be, and we started to reassess some of our architectural decisions and look for ways to cut costs.”

The next day, Amazon dropped its prices, too. Picturelife stayed with Amazon, which Westheimer said played a critical role in the company from the start. Westheimer said he doesn't believe he could have created a company if cloud services like Amazon's didn't exist.

Amazon is best known as an e-commerce giant that also dabbles in media. Among web businesses it serves a very different role. Amazon Web Services is the industrial farmer of the Internet, a cloud-based service that takes care of the arduous — but necessary — tasks that once cost startups large chunks of their capital.

Demand for this type of service has produced a market with no shortage of options. Google and Microsoft offer similar services, while Dropbox and Box lead a raft of smaller companies.

Prices for consumers are low, with most services offering a certain amount of free storage to individuals users. While still cheaper than building its own infrastructure, cloud services do get expensive. In a blog post, Westheimer pointed to Everpix, another photo storage startup that eventually ran up a bill with Amazon that it couldn't pay, forcing the company to close its doors.

Stronger, better, faster, cheaper

Two important factors precipitated the price cut: growing competition between established players and plenty of new entrants into the market, along with improvements in technology that lowered the operating cost for service providers.

“We knew [the price cut] was coming. They're very large companies that have continued to innovate over time and that's what makes them so successful,” said Mitch Wainer, cofounder and chief marketing officer of cloud services startup DigitalOcean. “The prices were a little too high. Knowing the business side of infrastructure, I know what their margins were in ballpark range, and they had plenty of room to cut back. They knew they could cut back and still be profitable.”

DigitialOcean is one of a variety of cloud startups seeking its niche. The company targets developers that want complex features in a simplified interface. Other companies, like StackDriver, sprung up around the space to help monitor cloud services.

Falling prices are great for consumers and companies, but savings can be fleeting. Growing companies can rapidly increase reliance on services, leaving them victims of their own success.

“I think that the price of storage is continually going down, but at the same time the amount of data we're creating is exploding,” said Sagalov, who is also a part-time partner at Y Combinator. “Ten years ago there were so few companies that had petabyte storage arrays.”

You get what you pay for

Falling prices call into question whether the quality of the services will remain at the same level. A Christmas Eve problem with AWS caused an outage of Netflix and other customers. While startups may be without other options for services, larger companies that are built on a single service rely heavily on the cloud provider.

"I can only assume both AWS and Google are going to offset the price drop by further over-subscription of their services to maintain margins,” said Lance Crosby, CEO of SoftLayer, IBM’s cloud infrastructure service in an email. “The financial benefit will be erased by the performance degradation leaving the customer at status quo.”

For now, Internet companies will enjoy a little more cash in their pockets. But if cloud prices continue to drop, the market could risk underpricing itself and minimizing necessary competition.

Box, which now trades publicly, operates at a loss having generated $124.2 million in revenue in its last fiscal year resulting in a loss of $168.8 million. The company has said it does not expect to be profitable in the near term as it continues to invest in the fast-growing, competitive market.

Raghu Kulkarni, founder and CEO of iDrive, among the oldest cloud storages companies around, said price drops are a good thing, but they can turn ugly if companies focus only on taking market share.

“Overall it's a helpful thing. From a consumer perspective, it's a great thing,” he said. “What one needs to be careful is about the extent of these drops. If someone is doing this just for the sake of gaining market share at a loss with an eye on the future, I think that's a dangerous game to play.”

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